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Hot Iron, Warm Hearts

CVRD seems to think that the market for iron is still on the upswing.

What goes up must come down. But there's nothing in that pithy little saying about "when" or "how." Even though these are grand times for iron ore producers such as CVRD (Companhia Vale do Rio Doce) (NYSE:RIO), management seems to think that it hasn't seen the top of the mountain just yet.

In a call with analysts, financial director Fabio Barbosa made several interesting statements regarding the metals market and CVRD's outlook. Notably, the company reported that it still does not have the capacity to meet rising demand. Asian customers continue to suck up iron beyond the rate at which the company can produce it. As a result, the company is hoping to increase production capacity to 275 million tons by 2007 -- as opposed to the 211 million tons produced last year and the almost 116 million tons produced year to date.

It also seems like further price hikes may be in the works. Barbosa wouldn't comment directly on the matter, but he did nothing to discourage the notion that prices could rise by double-digit amounts for 2006 -- that's on top of the 71.5% increase that went into effect this year. Certainly that would be good news to CVRD, as well as other diversified producers such as Rio Tinto(NYSE:RTP), BHP Billiton(NYSE:BHP), and Anglo American(NASDAQ:AAUK).

It will be interesting to see the extent to which steel producers can absorb further price hikes. Barbosa commented that this year's price hikes haven't really affected demand because they have been "practically entirely absorbed by the reduction of freight costs." Now, I think that's a bit of an overstatement, but I'm not going to contradict him -- after all, he knows the iron business firsthand, and I'm sitting at my desk a few thousand miles away.

There's one other bit of rumor swirling about that I'd like to address -- that being that CVRD is contemplating a bid for French metals company Eramet. Both parties have denied the story, but the rumor is that CVRD might pay $2 billion for this maker of superalloys and specialty materials.

Now, CVRD is certainly looking to diversify its operations, and the nickel alloys that Eramet makes would certainly fit into that, but I'm not so sure that CVRD wants to jump that far afield. In any case, the ownership structure of Eramet all but guarantees that any sort of deal will have to be on friendly terms, so this won't likely be any sort of drawn-out hostile battle if CVRD is in fact interested.